Not all QEs are created equal

July 19, 2017

Sometime between Fed QE1/2/3 and the ECB dithering over crossing the QE rubicon, there was a debate over whether the actions of the two central banks would have the same impact on global markets. Could ECB QE really be as powerful as Fed QE? In a world where the US Dollar has been King for so long, there was already a suspicion on the answer. In a word: No. The Fed were all powerful in propping up global markets. Weren’t the ECB just papering over the cracks of a bankrupt monetary union? (This snobbishness, by the way, is yet another example of how financial markets assume a political view without even realising it… No, Europe isn’t always a basket case, fighting itself with its silly accents, while the US reigns supreme…!)

Well, the ECB’s Benoit Coeure has now offered some incontrovertible evidence that European QE is ruddy well having an impact, thank you very much. In his speech, “The international dimension of the ECB’s asset purchase programme”, we get some pretty eye watering analysis of just how effective it has been:

It got money moving out of the Euro area

As Coeure points out:

‘At their peak around the middle of 2016, net capital outflows – measured here in terms of 12-month moving sums – reached nearly 5% of euro area GDP. Never before in the history of the euro area have capital flows been so high.’

So yeah, they got money moving alright.

2. And where did the money go? It went abroad…

Specifically, it went into foreign countries’ debt:

More specifically, it went into US Treasuries.

Let’s just let that sink in for a second. The Fed stopped QE, completing its taper, in October 2014. In January 2015, the ECB announced its Asset Purchase Programme. The effect of the ECB’s action was for domestic Eurozone investors to go out and buy other countries’ bonds. In effect, the ECB mandated another round of US QE.

3. Meanwhile they turbocharged their own QE….

They managed to get a significant portfolio shift into European equities. The ECB QE didn’t just work via lowering interest rates along the yield curve – it actually brought foreign investors back into European stocks:

As Coeure points out:

‘By the end of 2014, shortly before we announced purchases of government bonds, annual inflows into euro area stock markets by non-residents had reached 4% of euro area GDP – the highest on record. Policy stimulus and measures to repair the bank lending channel were clearly seen as having a positive effect overall on the euro area economy.’

So we’ve got the highest inflows into European equities from abroad, just as we’ve got the highest outflows from domestic Eurozone portfolios. Lots of records being broken. The QE programme was clearly having an impact.

The selling of European bonds in the chart above is the mechanical impact of the ECB having to buy up Eurozone bonds from wherever they could: and with ‘non-euro area investors…holding nearly 75% of German Bunds with maturities of seven to ten years’, this meant buying off a lot of foreigners. Not that they were too bothered:

‘In addition to yield differentials, the absolute yield level may also matter for investors, particularly if rates are negative. It may be no coincidence that net bond outflows were among the largest when ten-year German Bund yields hit a low of nearly -20 basis points last summer. In a recent survey among foreign central banks, 70% of the respondents reported that negative interest rates in the euro area had encouraged them to adjust their allocations to the euro.’

This had a currency impact, as foreigners sold their Euro bonds. That gave a second turbocharged boost to ECB QE, through the depreciation of the currency.

4. Didn’t Fed QE do all of this?

No, for a number of reasons. Firstly, foreign investors re-invested in the US even after their bonds were bought up, because they wanted exposure to the most liquid asset in the world. Secondly, this meant they retained an interest in the USD, so the currency didn’t take quite so much of a hit as the Euro. And finally, US investors went out into EM assets to find yield – whereas when the ECB started QE, EU investors could just go into the G4 for that yield:

‘Since the start of the APP in March 2015, ten-year US Treasuries have been yielding, on average, around 170 basis points more than ten-year Bunds – an enormous difference that, to a large extent, reflects the divergence in monetary policy cycles that emerged in the wake of the euro area’s sovereign debt crisis. As a result, portfolio rebalancing during the ECB’s asset purchase programme has been more attractive for investors than it was during the Fed’s QE programmes.’

In conclusion…

ECB QE had at least as much of an effect on the world as Fed QE

In fact, it had even more….

The EU bond buying ended up impacting the US Tsy market – the ECB were doing US QE by the back door, as they forced their domestic investors to buy bonds elsewhere

Negative rates forced a portfolio rebalance out of Eurozone bonds into equities – so European stock markets got even more of a kicker

And the currency was deliberately driven lower

So the ECB managed to do their own QE plus deliver it for the Fed; rescue their stock markets from depression; and reinflate through the currency.

The ECB are about to unwind all of this. Why else would Coeure be making this speech now? He spends the final half of it explaining what a great favour they did to the world, which sounds exactly like what you might tell a drug addict after peddling him cheap drugs for years before pulling the plug. (“You enjoyed those years, didn’t you….??”)

That means a reversal of all of those effects:

US bonds will no longer receive an ongoing bid.

European equities will have to survive on their own two feet.

The Euro depreciation will reverse.

This means that the greatest lie we were ever told was that the Fed taper was the end of the cheap money party. The Fed may have stopped QE and started raising rates, but the actual impact on their bond market is little. It’s as if it never happened. Just check out this chart of how the loose monetary policy has kept on coming and coming:

The taper tantrum hasn’t happened again because the tapering hasn’t really happened, at least not globally. So, if the ECB tomorrow signal that they’re starting to turn off the taps, and if Draghi lays out the path in his guest appearance at Jackson Hole in August, then just wait for the mother of all tantrums to emerge. I’ll scweam and scweam and scweam until I’m sick…